Demand risk

Description (What is the Risk)

The availability by both volume and quality along with transportation of resource or inputs to a project or the demand for the product of service of a project by consumers/users

Risk Allocation (Who typically bears the risk)

Allocation:PublicPrivateShared

Rationale

Under a typical franchise agreement, this risk will largely be taken by the Operator but will be mitigated by the revenue share obligations imposed on the Operator and revenue support obligations imposed on the Contracting Authority.

Alternatively the Contracting Authority may decide to take this risk, in which case it will require the Operator to enter into a management contract.

Mitigation Measures (What can be done to minimize the risk)

Under a typical franchise agreement, the Operator will be required to share a proportion of its revenue exceeding a specified threshold with the Contracting Authority, and will be entitled to receive revenue support from the Contracting Authority if its revenue is below a specified threshold. Revenue share arrangements do not normally apply during the first 4 years of a franchise agreement.

Government Support Arrangements (What other government measures may be needed to be taken)

If the Contracting Authority will be retaining demand risk, it will need to ensure that it is comfortable (both politically and economically) with demand forecasts.

Comparison with Emerging Market

In developed markets, the Contracting Authority should have access to various data sources to develop realistic and attainable ridership and revenue forecasts, such that the Contracting Authority is well placed to manage demand and farebox risk. However, within certain parameters, the Contracting Authority may feel that the Operator should take a degree of this risk.

Description (What is the Risk)

The availability by both volume and quality along with transportation of resource or inputs to a project or the demand for the product of service of a project by consumers/users.

Risk Allocation (Who typically bears the risk)

Allocation:PublicPrivateShared

Rationale

The default position for existing rail ROT projects in emerging markets is for the Private Partner to retain demand and tariff risk (risk of demand and total revenue receipt).

To the extent that tariff revenue may be insufficient to cover the cost of financing and operating the project in question, as well as meeting the likely project contingencies, then some form of taxation-based support within the payment structure will be required, and the Contracting Authority may need to retain an element of demand risk.

Mitigation Measures (What can be done to minimize the risk)

Both the Contracting Authority and Private Partner should do a full assessment of demand risk and should ensure that the concession agreement appropriately addresses and allocates the risk for everything that will impact on demand.

The parties should also develop a comprehensive market strategy to deal with the implementation of the project.

Government Support Arrangements (What other government measures may be needed to be taken)

There may need to be an element of subsidy from the Contracting Authority if demand falls below a certain amount. If this is structured as a 'cap and collar' arrangement then the Contracting Authority should also start to benefit from economic upsides above the Private Partner's base case. This is not universally included and does not necessarily reflect a market practice.

If there is high uncertainty over passenger projections and uncertainty over revenues (due to tariff limitations and/or currency volatility) then the project may need to be structured purely on the basis of an availability fee.

Comparison with Developed Market

Most demand risk rail projects in the world have over- estimated user and revenue forecasts, and restructurings have been common. This creates a difficulty for Contracting Authorities in emerging markets, particularly in the case of market first projects, where there is likely to be a lack of relevant comparative market data to begin with.

When a project, or part of a project, cannot be covered by any insurance policy or insurance cover cannot be obtained on the specified terms, or when it is not commercially feasible to obtain an insurance policy for the project or insurance cover on specified terms.

An event that allows for an innocent party to terminate a contract in the event that the other party to the contract breaches its obligations.

The fee charged to a party to the contract when it wants to break the contract.

The rate at which prices for the project output – for example, electricity in the context of a project in the energy sector - are paid between the Contracting Authority and Private Partner, in relation to either a predetermined price or agreed formula.

The party who fulfils the obligations of the Private Partner in the event that the concession agreement is novated.

Contractual clauses that entrench certain legal provisions, enabling foreign investors to protect themselves from changes in the law and a certain degree of political risk.

The party that is the ultimate owner of the Private Partner. It invariably includes the major project parties such as construction contractor and commonly includes financial investors or funds. Sponsors will limit their liability to the project through the Private Partner but may need to give limited support or guarantees to the lenders of the senior debt, particularly during the construction phase.

If one of the contracting parties is owed monies by another contracting party, the debtor’s right of set-off allows it to balance mutual debts with the creditor.

Money that is borrowed by the Private Partner to finance a project that takes priority over any ‘junior’ debt (lower down the order of priority) or equity in the event that the project company becomes insolvent.

The project structure whereby the Private Partner receives from the Contracting Authority an existing asset, may then upgrade, improve or rehabilitate that asset and then operate and maintain the asset to the agreed standard and subsequently transfers it back to the Contracting Authority after a specified period of time (typically somewhere between 25 and 30 years in the transport sector and 15 and 25 years for energy and waste/water). The Contracting Authority should carefully consider the quality of the asset it expects to receive back at the end of the term and how to ensure that the Private Partner ensures that the asset achieves that standard.

The project structure whereby the Private Partner receives from the Contracting Authority an existing asset, may then upgrade, improve or rehabilitate that asset and then operate and maintain the asset to the agreed standard and subsequently transfers it back to the Contracting Authority after a specified period of time (typically somewhere between 25 and 30 years in the transport sector and 15 and 25 years for energy and waste/water). The Contracting Authority should carefully consider the quality of the asset it expects to receive back at the end of the term and how to ensure that the Private Partner ensures that the asset achieves that standard.

The entity employed by the Private Partner or subsidiary to build the project.

The entity from the private sector that undertakes the project typically through the use of a special purpose vehicle incorporated specifically and only for the purposes of undertaking the project.

A force majeure event that is brought about by the direct acts of the Government, such as a nationwide strike protesting the Government’s actions, or by indirect events affecting the Government, such as war. Similar terminology used may include “material adverse Government action / events of Government action / inaction / buyer risk events (which may also extend to Contracting Authority breach).

The document outlining the way in which the project must be operated throughout the life of the concession agreement and typically includes KPIs.

Benchmarks to measure performance and of the project, or the parties’ contribution to the project. These are typically referenced to the output specification and are the benchmark against which the Private Partner is incentivised to perform. If the Private Partner falls short of the performance indicators then typically deductions will be made and in persistent or material circumstances a right of termination may arise. It is imperative that the Contracting Authority runs a sensitivity analysis in the payment mechanism to calibrate the deductions.

Benchmarks to measure performance and of the project, or the parties’ contribution to the project. These are typically referenced to the output specification and are the benchmark against which the Private Partner is incentivised to perform. If the Private Partner falls short of the performance indicators then typically deductions will be made and in persistent or material circumstances a right of termination may arise. It is imperative that the Contracting Authority runs a sensitivity analysis in the payment mechanism to calibrate the deductions.

The formulae used to assess performance of the project and to calculate the payments to be made to the Private Partner assessed against their compliance with the performance indicators.

The document outlining the levels of capacity from the project from a technical and financial perspective that are required in order to ensure the projected is built to the desire standard and is profitable. It is critical that Contracting Authority gets this document right as it is the functional demand of the project that the Private Partner will build and perform to.

The functional stage of the project after the construction phase when it adequately operates, finishing with the end date of the concession agreement.

Operation and maintenance – where a party is responsible for the continual functioning of the project after the commercial operations date.

Replacing one of the parties to an agreement with another party who consequently takes on the rights and obligations of the party who is no longer bound by the contract (in contrast to an assignment whereby, typically, only rights can be transferred).

Replacing one of the parties to an agreement with another party who consequently takes on the rights and obligations of the party who is no longer bound by the contract (in contrast to an assignment whereby, typically, only rights can be transferred).

The situation in which the contract can be terminated by an event that is not brought about by either party breaching their contractual duties (e.g. termination for extended force majeure or termination by agreement).

A force majeure event that is brought about by an act of nature, for example, an earthquake.

Manufacture and supply agreement.

A date which is tied to a prescribed time period after a scheduled completion date by when all obligations must have been fulfilled otherwise a right of termination will typically arise.

A specified monetary amount paid for a specific contractual breach that aims to compensate the injured party for the loss it suffers for such breach. Such amounts are agreed up front and in many common law jurisdictions must be a genuine pre-estimate of loss to withstand challenges that such regimes are unenforceable because they are deemed a penalty.

A specified monetary amount paid for a specific contractual breach that aims to compensate the injured party for the loss it suffers for such breach. Such amounts are agreed up front and in many common law jurisdictions must be a genuine pre-estimate of loss to withstand challenges that such regimes are unenforceable because they are deemed a penalty.

The costs associated with terminating any hedging arrangements prior to their expiry.

An instrument used to limits exposure to a price or unit of value that fluctuates. These typically cover interest rate, foreign currency exchange rates or commodity prices and/or inflation.

Circumstances that easily and disproportionately allow a party to terminate all or part of contract with no genuine prospect of the offending party remedying the issue.

The period after an obligation is due for performance during which such obligation may still be performed without declaring an event of default and/or termination.

Where the Government in the jurisdiction in which the project is based actively uses its powers to enable the project to function, or acts in a passive manner whereby it does not prevent the project from commencing. Such support may extend to guarantees if the Contracting Authority is perceived by the Private Partner to be a credit risk and/or other fiscal measures designed to stabilise any jurisdictional uncertainties that make the project not bankable (e.g. foreign currency protections and tax breaks)

Parties who provide capital to the project enabling it to commence, seeking to make gains on the monies provided in the form of interest payments or a proportion of profits from the project (i.e. equity return).

The legal or beneficial interests in the land on which the project will be built that belongs to local citizens or affects their customs in a material way.

The document outlining the required specification of as-built project and how the project is to operate in practice.

Circumstances in the reasonable contemplation of the parties given their knowledge at the time of entering into the concession agreement. Unforeseeable having the opposite meaning.

Circumstances in the reasonable contemplation of the parties given their knowledge at the time of entering into the concession agreement. Unforeseeable having the opposite meaning.

An event, outside the control of the contracting parties, that results in one or both of the parties being unable to fulfil their contractual obligations. In common law jurisdictions the definition of force majeure is typically a matter of drafting and negotiation whilst in civil law jurisdictions is normally set out in the relevant civil or commercial code.

The amount of time that one stage of the project can be delayed without causing delay to any subsequent stages of the project.

The key finance documentation which typically includes a facility agreement with one or more commercial lenders, an intercreditor agreement between the commercial lenders, equity investors and Private Partner, direct agreement(s) and security documents.

Where the Government takes privately owned property and declares it for public use.

The amount of a company’s net income returned as a percentage of the shareholders’ equity.

Monies used to finance a deal that is sourced from the existing finances of a company (for example, raised through the issuing of shares in the company), rather than though external debt (for example, from commercial lenders).

A risk management framework, adopted by financial institutions, for determining, assessing and managing environmental and social risk in projects. It is primarily intended to provide a minimum standard for due diligence to support responsible risk decision-making. These can be found at: http://www.equator-principles.com/

A form of contracting arrangement where the contractor is made responsible for all the activities from, procurement, construction, to commissioning and handover of the project to the principal/owner. Often, referred to as a lump-sum turnkey contract.

A market in which few large-scale industrial projects have been commenced, often with a legal structure that can lead to a degree of unpredictability, for example, uncertainty in the need for particular licences.

An agreement between the Contracting Authority, Private Partner and the lenders under which the Contracting Authority agrees to give the lenders contractual remedies in the event of the Private Partner defaulting under its contractual obligations before the Contracting Authority can terminate the concession agreement.

An agreement between the Contracting Authority, Private Partner and the lenders under which the Contracting Authority agrees to give the lenders contractual remedies in the event of the Private Partner defaulting under its contractual obligations before the Contracting Authority can terminate the concession agreement.

A market that frequently witnesses large-scale industrial projects with a stable economy and legislative system capable of governing and enforcing the concession agreement in a fair and predictable manner.

The project structure whereby the Private Partner designs and then builds the project asset in question. It then finances and retains the responsibility to operate the project.

The project structure whereby the Private Partner designs and then builds the project asset in question. It then finances and retains the responsibility to operate the project.

Projects which rely on demand forecasting (e.g. road and rail use) to determine the bankability of the project.

Where an innocent party exercises its contractual right to terminate the concession agreement in whole or in part due to the other party’s actual or anticipatory failure to perform its contractual obligations.

A method, set out in the payment mechanism by which payments to the Private Partner are reduced if it fails to meet the key performance indicators. Sometimes called Abatements.

A minimum threshold often used in concession agreements to benchmark when something is of a material nature, thereby triggering a consequence under the agreement.

The Government or other public sector entity, either acting in its own capacity or acting on behalf of the state, which contracts with the Private Partner under the concession agreement.

The period from when the Private Partner takes control of the project site (typically by reference to the date of signing or effective date (if conditional) of the concession agreement or the commencement of construction by reference to certain works) until the commercial operations date.

The agreement outlining the terms on which the project will be undertaken (e.g. BOO, BOOT, BOT). In the energy sector, this is typically the PPA.

The agreement outlining the terms on which the project will be undertaken (e.g. BOO, BOOT, BOT). In the energy sector, this is typically the PPA.

The process whereby the Contracting Authority does not give the local land owners a choice to sell their land, but rather uses its legislative powers to compel them to sell for a predetermined price.

Steps taken to ensure that the project in question can adequately function in the local community. This may be by developing the land in a way that is as compliant as possible with local customs, employing a certain amount of local citizens or engaging with local businesses.

The date on which the construction phase of the project is successfully completed (typically determined by some form of independent certification and/or testing regime); the scheduled COD represents a target date for such successful completion with failures to achieve that date having commercial consequences (typically delay liquidated damages and/or termination).

The date on which the construction phase of the project is successfully completed (typically determined by some form of independent certification and/or testing regime); the scheduled COD represents a target date for such successful completion with failures to achieve that date having commercial consequences (typically delay liquidated damages and/or termination).

The date on which the construction phase of the project is successfully completed (typically determined by some form of independent certification and/or testing regime); the scheduled COD represents a target date for such successful completion with failures to achieve that date having commercial consequences (typically delay liquidated damages and/or termination).

The date on which the construction phase of the project is successfully completed (typically determined by some form of independent certification and/or testing regime); the scheduled COD represents a target date for such successful completion with failures to achieve that date having commercial consequences (typically delay liquidated damages and/or termination).

The parties, typically international banks but may also include local banks, who provide financial backing to the project, taking an interest by way of security – often of the asset in question or the project as a whole.

The amendment or passing of new laws, as well as new interpretations of laws, that conflict with the laws affecting the project and impact upon the project; change in law protection may be subject to a specified level of materiality before any protection is given (e.g. demonstrating the change has a minimum financial impact on the Private Partner).

An agreement not to go above (cap) or below (collar) certain amounts in relation to a particular requirement (e.g. subsidy levels in the case of a “cap and collar subsidy arrangement”).

The project structure whereby the Private Partner builds the asset in question, maintains the responsibility of operating the asset and then transfers the asset back to the Contracting Authority after a specified period of time (typically somewhere between 25 and 30 years in the transport sector and 15 and 25 years for energy and waste/water). The Contracting Authority should carefully consider the quality of the asset it expects to receive back at the end of the term and how to ensure that the Private Partner ensures that the asset achieves that standard.

The project structure whereby the Private Partner builds the asset in question, maintains the responsibility of operating the asset and then transfers the asset back to the Contracting Authority after a specified period of time (typically somewhere between 25 and 30 years in the transport sector and 15 and 25 years for energy and waste/water). The Contracting Authority should carefully consider the quality of the asset it expects to receive back at the end of the term and how to ensure that the Private Partner ensures that the asset achieves that standard.

The project structure whereby the Private Partner builds the asset in question, has full ownership of the asset and maintains the responsibility of operating the asset.

The project structure whereby the Private Partner builds the asset in question, has full ownership of the asset, maintains the responsibility of operating the asset and then transfers the asset back to the Contracting Authority after a specified period of time (typically somewhere between 25 and 30 years in the transport sector and 15 and 25 years for energy and waste/water). The Contracting Authority should carefully consider the quality of the asset it expects to receive back at the end of the term and how to ensure that the Private Partner ensures that the asset achieves that standard.

The project structure whereby the Private Partner builds the asset in question, has full ownership of the asset and maintains the responsibility of operating the asset.

The project structure whereby the Private Partner builds the asset in question, has full ownership of the asset and maintains the responsibility of operating the asset.

Projects which entitle a Private Partner to receive regular payments from a public sector client to the extent that the project asset is available for use in accordance with contractually agreed service levels.